12/08/2006 @ 5:20PM

A Room Of Your Own

Buyers are spending millions on a hot new real estate play: condo-hotels. Good as second homes. Terrible as investments.

Christopher Kearney is getting a piece of a gleaming hotel that will open off the Las Vegas Strip in 2009, complete with deluxe shopping, fine dining, a gorgeous waterfall-fed pool and, of course, a casino. His slice of the W Las Vegas is ownership of a 600-square-foot room. A condo, that is. When he’s not there, the space will be rented out, with the hotel operator and Kearney splitting the proceeds.

As the lodging industry continues to boom, with occupancy rates and room rents surging, opportunity-minded hoteliers have turned to investors like Kearney to help underwrite expansions. These joint-ownership deals, called condo-hotels, have blossomed only in the past two years, with buyers spending an estimated $250 million on units in 2006, mainly in resort areas. Donald Trump’s Waikiki condo-hotel development sold out in one day, for a total of $700 million.

By January, 27 such projects should be open. In the next two years 76 more are slated. Since the promoters are selling what’s hip and glitzy, most are offering units in new hotels, not long-standing ones, but there are exceptions, such as New York’s fabled Plaza, which will be a condo-hotel. In the right circumstances condos sell out in a matter of weeks, on spec, well before the first shovelful of dirt is dug. Demand is so high that prices can double between the time the first buyers get in and the last ones do.

The sales pitch: Own a little piece of paradise in Hawaii or Las Vegas without worrying about finding renters–or plumbers when the toilet backs up–and you’re thousands of miles away. If you’re lucky, the split room rent will cover your mortgage and overhead.

Kearney is so enticed by this concept that he has bought two rooms at the
Starwood
-branded Vegas hotel (25% of its 2,000 units will be condos), plus eight more in places like Panama, Grand Cayman and Dubai, for $4.8 million in toto. He’s putting down $3 million, borrowing the rest. The 47-year-old personnel executive from Mahopac, N.Y. says, “I’ll be buying and selling these things for as long as I live.”

But will he be selling at a profit? Since so many condo-hotels are under construction, and since the industry is so new, it’s hard to know how well these investments will fare. But common sense says that they aren’t likely to be gold mines. If the operators were confident about high rental income, they wouldn’t be cutting you in; they’d just borrow from a bank.

From what evidence we have to date, the fees can be very high, and there’s no guarantee that rooms will be rented out often enough to cover costs. What’s more, a danger exists that some roaring markets, like Miami’s, are becoming overbuilt.

Vexingly, prospective owners can’t see how the costs and revenues will be divided until they fork over a down payment. And real estate agents and developers are barred by securities regulations from divulging room rates or expected occupancy levels, which would make the condos into investments rather than real estate. Perish the thought.

You have a limited time to get your money back once you review the numbers. “It’s a catch 22,” says Dante Alexander, head of the National Association of Condo Hotel Owners. “Most people buy them to rent out, but developers can’t talk about it.” His organization offers members market analysis to help guess rental income. Still, this is more art than science.

A rundown of possible problems:

Mortgages. Getting one for a condo-hotel can cost more than a standard loan. Mostly,
Fannie Mae
won’t buy condo-hotel mortgages, which makes big banks leery about extending them. If a room lacks a kitchen and other apartment-like features, few traditional lenders will want it.

But brokers peddling condo-hotel rooms have lists of specialty lenders who make these loans, often for 0.25 to 0.75 percentage points more than a home mortgage. Robert Waun of Vacation Finance, a mortgage firm focused on condo-hotel lending, expects to originate $100 million in loans next year.

Occupancy. Hotels almost never offer buyers a guaranteed minimum number of days the room will be rented out. If you base your cash flow analysis on the hotel’s being full 75% of the year, and the real occupancy rate (because of bad weather, bad economics or bad marketing) is only 40%, that’s 219 days your room is costing you money.

Look at the MGM Mirage Signature, a 1,728-unit development attached to the MGM Grand casino on the Vegas Strip. The first of three buildings opened last June to little fanfare. The hotel boasts a gated entry, large rooms, flat-screen televisions and a private pool. Owners expected their rooms to be rented out at Las Vegas’ typical 85% occupancy rate for $200 and up per night. But angry owners say that mgm isn’t properly marketing the property and is renting rooms on the cheap.

One owner says his room was rented out only 8 nights in September. He did a little better the previous month, when his room was taken for 15 nights, although some of those were at a cut-rate $90 per night. “I expected to earn $2,000 per month,” says Dean Ader, a retired accountant who owns a 550-square-foot room at the Signature. “One month I got a check for $425.” MGM says owners shouldn’t look at rooms as investments but as second homes, thus financial expectations like Ader’s are unjustified. No lawsuits have been launched on this yet, but wait.

Potential Glut. Ader now has his unit, which he bought for $395,000, for sale at $489,000. After closing costs he expects to earn $30,000 from his investment. That might be optimistic.

At least 160 other Signature units are for sale, and Bruce Hiatt, of condo-hotel-seller Luxury Realty Group, expects dozens more to follow once the property has been open a year and a day, giving owners long-term capital gains benefits. A resale glut is likely to keep prices in check. Biggest risks for resellers are in Las Vegas, Orlando, Miami and Ft. Lauderdale: 40% of new projects are going up in those hot markets.

Fees. The rental-income split looks favorable, typically 50% to 60% to the owner. But you have to pay all of a maintenance fee (usually $10 per year per square foot) out of your share. Management will often hold out an extra 3% to 5% to pay for repairs, like a new roof, or furniture.

Kearney bought his room at the W Las Vegas for $493,000 (his broker got him in before units went on sale to the public for $650,000). If he snags a five-year interest-only loan, common for condo-hotels, he’ll pay $23,664 yearly. Once the hotel is built, he must shell out for a condo fee ($6,000), insurance ($250), a furniture replacement fund (5% of gross rentals) and taxes ($4,930). Then add $40 for maid service each day it is rented. Now assume the room is full 75% of the year, at $270 per night. He collects just 55% of rental income, or $37,000. Result: He’ll be $12,500 a year in the hole.

Kearney plans to flip the place to another speculator once it opens. All he has to do is find someone who wants to lose money.